If software development costs incurred in the current period exceed amortization of prior periods’ capitalized development costs, net income for the current period would most likely be:
Can someone explain this question to me? I don’t understand what it’s asking.
It’s asking whether you understand the implications of expensing vs. capitalizing.
If you expense, then prior periods’ development costs have no effect on current period income, but current period’s development costs are deducted 100%.
If you capitalize, then current period’s development costs only reduce current period income by the amount amortized, and prior periods’ development costs also reduce current period income by the amount amortized.
The question, as written, cannot be answered, because it was poorly written. They want you answer: 2. Lower under expensing; if you expense this period’s costs, it will be more than amortizing prior periods’ costs, so net income would be lower.
The problem with the wording is that if you capitalize the costs, then this period you would not only amortize a portion of prior periods’ costs, you would also amortize a portion of this period’s costs, and we’re not told whether the sum of those two amortizations exceeds this period’s costs; we’re only told that that the first (prior periods’ amortization) doesn’t.
It’s a good idea, but poorly executed.